Wednesday, September 26, 2012
The main reason Romney's effective rate is so low is that the American tax code contains a lot of preferences for investment income over labor income. That's something that strikes many people as unfair on its face, and particularly unfair since it often means very low rates for extremely rich people like Rommey. ... But this is definitely an issue where the conservative position is in line with what most experts think is the right course, and Democrats are outside the mainstream.
The reasoning is basically this. You imagine two prosperous but not outrageously so working people living somewhere—two doctors, say, living in nearby small towns. They're both pulling in incomes in the low six figures. One doctor chooses to spend basically 100 percent of his income on expensive non-durables. He goes on annual vacations to expensive cities and eats in a lot of fancy restaurants. The other doctor is much more frugal, not traveling much and eating modestly. Instead, he spends a lot of his money on hiring people to build buildings around town. Those buildings become houses, offices, retail stores, factories, etc. In other words, they're capital. And capital earns a return, so over time the second doctor comes to have a much higher income than the first doctor.
So then there are too different scenarios:— In the world where investment income isn't taxed, the second doctor says to the first doctor "all those fancy vacations may be fun, but I'm being much more prudent. By saving for the future, I'll be comfortable when it comes time to retire and will have plenty left over to give to my kids."— In the world where investment income is taxed like labor income, the first doctor says to the second "man you're a sucker—not only are you deferring enjoyment of the fruits of your labor (boring) but when the money you've saved comes back to you, it gets taxed all over again. Live in the now."That's the theory, at any rate. It's a pretty solid theory, it's in most of the textbooks I've seen, and it shapes public policy in basically every country I'm familiar with.
And the thinking is that world number one where people with valuable skills take a large share of their labor income and transform it into capital goods is ultimately a richer world than the world in which such people just go out to a lot of fancy dinners.
Ezra Klein's WonkBlog (Washington Post): Why Romney’s Tax Rate Should be Low, by Dylan Matthews:
[T]he disagreement among economists isn’t about whether people like Romney are paying too little. It’s about whether or not they’re paying too much.
For contrary views, see:
- Angry Bear, The Effect of Capital Gains Tax on Investment
- Ezra Klein's WonkBlog (Washington Post): The Case for Raising Taxes on Capital Gains, by Ezra Klein
- New York Times op-ed: Romney and the Forbes 400, by Joe Nocera
- Start Making Sense: Should Romney Pay a Lower Tax Rate Than the Rest of Us?, by Dan Shaviro (NYU)